Building a Case for Being a US Dollar Bull

The US Dollar Index (‘DXY’) is an index that values the US Dollar relative to a basket of major currencies. When the index goes up, the US Dollar is strengthening versus this basket, and when the index goes down, the US Dollar is weakening relative to the basket of major currencies. The US Dollar Index is a weighted geometric mean of the US Dollar’s value relative to the following major currencies:

  1. Euro (EUR 57.6%)
  2. Yen (JPY 13.6%)
  3. Pound (GBP 11.9%)
  4. Canadian Dollar (CAD 9.1%)
  5. Swedish Krona (SEK 4.2%)
  6. Swiss Franc (CHF 3.6%)

Using classic technical analysis, inter-market analysis, and a graphical representation of rotation in currencies, I will try to build a case for being bullish on the US Dollar Index versus all major currency pairs.

Support and Resistance, Trendlines, and Percentage Channels

Chart A: Historical, Long-Term Trendline Resistance

  • Beginning with the highest high in 1986 and the subsequent next highest high in 2001
  • I believe this trendline, which is long-term resistance, will be challenged in the future

Chart B: Medium-Term Trendline Support and Resistance with Percentage Channels

  • Medium Term Resistance
  • Beginning with the high in 2007 and the subsequent high at the end of 2016
  • Medium Term Support
  • Beginning with the lowest low in 2011 and the subsequent low in 2014

Observations and Eventual Outcome

The US Dollar Index is moving in an upward sloping, medium-term channel that is bound by an approximate 20-25% range. Although we are in the lower-half of this upward moving channel, it doesn’t mean that we cannot consolidate around these levels for an extended period of time. We do not necessarily have to immediately move higher. It wouldn’t be a surprise to consolidate around the 88 – 92 range for an extended period.

The longer it takes for the US Dollar Index to reach the historical resistance in ‘Chart A,’ the lower this trendline will be. There is nothing that uses time as a factor pictured in ‘Chart A’. Time could be more of a factor in ‘Chart B,’ and the approximate 20-25% channel could possibly extend out to the mid 2020’s.

Using Intermarket Analysis to Support the Case for Being a US Dollar Bull

The goal of intermarket analysis is to compare the performance of two or more instruments that are in related markets to try to find correlations or connections in price series. We will use the historical movements of an international interest rate differential to try to find some indication of where the US Dollar is headed:

  • US 10-Year Note – German 10-Year Bund spread
  • US Dollar Index (orange line)

Looking at a chart beginning in 2012 of both price series overlaid on top of one another, it seems as the US Dollar Index (orange) is influenced by this international rate differential.

  • As the spread increases, the US Dollar (orange) seems to pick up and follow, albeit with significant delay in some cases

Observations and Eventual Outcome

  1. In June of 2017, the correlation between the two pairs fell apart
  2. The last time this happened, which was July of 2014, it took almost one year for the US Dollar Index (orange) to begin to catch up to the gain in the spread between the US 10-YR and German 10-YR
    • It has almost been one year since the correlation fell apart in June 2017
  3. Looking at the recent movements of both the interest rate differential and the US Dollar Index (orange), one could potentially make a case for simultaneously shorting the spread differential and buying the US Dollar Index (orange).
    • For instance, buying the US Dollar in isolation would not be acceptable, as the interest rate differential could collapse, and the US Dollar Index (orange) could potentially remain stationary.
    • Being able to accurately execute this trade would be difficult. It would involve the use of derivatives and greater detail than what could be expressed here.
    • In the case, we want to use this inter-market analysis in context only as a piece of the puzzle within the bigger picture, which could possibly indicate that the US Dollar (orange) will move higher as this spread differential moves higher.

Using a Relative Rotation Graph to Support the Case for Being a US Dollar Bull

A relative rotation graph (RRG) is a visual means to display relative trends in the marketplace, in a very concise and quickly comprehensible manner.

The RRG is composed of four quadrants:

  • Upper Right (Leading)
  • Bottom Right (Weakening)
  • Bottom Left (Lagging)
  • Top Left (Improving)

The x and y-axis represent quantitative data points:

The X-axis: Relative Strength

  • Move to the right = positive relative strength to benchmark
  • Move to the left = negative relative strength to benchmark

The Y-axis: Momentum

  • Move upwards = positive momentum relative to benchmark
  • Move downwards = negative momentum relative to benchmark

The resulting datapoints that represent our securities will actually move clockwise, or rotate, around the benchmark, which is assumed to be in the middle of the rotation graph. The wider the swing around the benchmark, the greater the chance for under/out performance. Securities that are closely rotating around a benchmark have a less chance for future under/out performance.

The following GIF is a Daily RRG that encompasses the most recent bullish run in the middle of April through May 1st, and will show you the relative rotation of other major currencies around the benchmark, the US Dollar.

Other Interesting Things to Note in the Chart of the US Dollar Index

The length between the two previous high’s and low’s in the US Dollar Index

  • The highest high, where the chart begins in 1985, to the lowest low in 1992 was approximately 2500 days
  • The subsequent next highest high to the lowest low was also approximately 2500 days

The length between the first high in 1985 in the US Dollar Index and the next subsequent highest high in 2002 was approximately 5800 days

  • It has been approximately 5900 days since our last high in 2002

Putting it all together

Using classical technical analysis techniques, such as support and resistance, intermarket analysis, and a graphical representation of rotation amongst major currencies, we can start to begin to make a case for a bullish US Dollar Index in the future.

Zooming in on the chart, from the recent support levels at 88.95, it would be an approximate 2.2:1 risk/reward scenario if one were to enter the trade in hindsight.

Risk could be greatly improved by placing a stop at the lower, upward moving red-dotted support line that is presently at an approximate 87.50. This would be in place of the stop I show below, which is under the last low in 2015, which is approximately at 80.

If you look closely, outlined in blue, is a recent consolidation we have recently broke out of to the upside. I believe we may come back to test this blue line at some point. This may be a prudent time to enter the trade if the recent bullish momentum has one looking to enter without getting in with the rest of the crowd.

  • Upside Approximate Target = 107
  • Downside Approximate Target = 80